National Grid bonds are not without risk

 
Philip Salter
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INFLATION stealthily redistributes wealth from those with savings to those with debts – which is why highly indebted governments often turn a blind eye to it. But as important as it is to beat inflation, your investment strategy should be driven by facts, not fear.

For those who missed out on the National Savings and Investments (NS&I) inflation-linked bond, recently taken off the market, the temptation to jump into the hot-off-the-press National Grid inflation-linked bond might be overpowering. These bonds will be issued from 6 October until 29 September – or could finish earlier if there is enough demand – and if held for the full ten years, investors are promised an annual 1.25 per cent above inflation (paid semi-annually) and the original investment adjusted for inflation. At just £2,000, with additional £100 increments, there is a relatively low barrier of entry. They will be available through most brokers and can be sheltered from tax in an Isa or Sipp. Tempting, but investors should be alert to the risks before signing up.

CURRENT RISKS
Although the National Grid is a government monopoly, it could still go bust – which could prove costly for bond holders, as this investment isn’t protected by the Financial Services Compensation Scheme (FSCS). Although conservatively managed, there is nevertheless a risk that poor management or regulatory changes could lead to its demise. The current plight of the postal services in the UK and US show that government protection can’t guarantee balanced books.

Because the National Grid bond can trade below par, Hargreaves Lansdown’s Danny Cox warns “investors could lose money if they take the money out early.” Anna Sofat of Addidi urges investors to understand that this is not a simple bank deposit paying 1.25 per cent over the retail price index (RPI). She stresses that this is a corporate bond issue with RPI adjustment. Sofat says: “If the RPI in February 2021 is lower than that in February 2011, there will be no adjustment of the principal amount returned at maturity (October 2021).” On the positive side, Luke Gale of Ashburton says, in contrast to inflation-linked gilts, in which the face value of the bonds is not guaranteed, the National Grid bond has a floor at zero. Thus: “If we enter a period of deflation and the RPI figure in 2021 is lower than that of the base RPI figure – relating to February 2011 – the bond holder will still receive the face value of the bonds at maturity.”

INFLATION SPECULATION
“This bond is very much a speculation on inflation over the next 10 years,” says Sofat. Patrick Connolly of AWD Chase de Vere cautions: “While the product looks good now with inflation high, the rate of inflation is expected to fall in 2012, not least when the impact of January’s VAT rise is no longer included in the figures, and it is likely that it will look far less attractive then.” Cox notes that the markets current “prediction for inflation over the next ten years is 2.639 per cent, per year.” Although Adrian Lowcock of Bestinvest cautions that economists tend to get their predictions wrong.

The safer inflation hedge of a NS&I inflation linked bond cannot be substituted for a corporate bond of any sort, as a Standard and Poor’s rating of BBB+ on this one makes clear. Andrew Swallow of Swallow Financial Planning says they are “chalk and cheese.” Stuart Fowler of Fowler Drew thinks National Grid’s bond should be ignored, because unlike the NS&I bond, it is not a perfect hedge: “You cannot own enough different issues to spread the credit risk, making it fundamentally unattractive, having tail risk as large as equities but without the real-return upside potential.”

Connolly advises those looking to invest in corporate bonds to spread their risk in an investment fund such as the M&G Corporate Bond fund or Fidelity MoneyBuilder Income fund, yet on the former Swallow is reticent about its reliance on credit default swaps. The moral of the story is, as always, caveat emptor, especially with products as complicated as this.